When being INFORMAL comes with incentives

Nepal’s economy is largely informal; informal sector here comprises of a group of production units that form part of the household sector as household enterprises or equivalently, unincorporated enterprises owned by households. Much likely, such units have limited capital investment and are a subsidiary activity of the owner. Their activities are not regulated under any legal provisions and/or they do not maintain any regular accounts. In Nepal, a good chunk of production and consumption is contributed through such informal sector activities. The sector also contributes to much of the income generation through employment thus providing means of livelihood to millions of Nepalese. Kirana Pasals that are small mom and pop shops selling groceries and fast moving consumer goods form a major segment of this informal economy in Nepal.

What makes these shops informal can be attributed to an endless list of reasons—a primary reason being that informality to these shops means a much better deal than choosing to formalize their operations. Given, the informal sector helps during economic crisis. But the fact that the benefits of informal employment may not be sufficient to achieve an acceptable standard of living as informal employment rarely comes with social protection, good working conditions and adequate wages cannot be ignored for long. But in our case, the scenario of choosing informal as opposed the formal begs to not be changed until a few things are set straight.

First in the list being the registration of these Kirana Pasals. Such shops are required to register at four different places; these fall under the jurisdiction of six major government agencies and they are subjected to 15 major laws and policies. Given their size and monetary weaknesses, these shops have less capacity than larger firms to navigate through the complexities of regulatory and bureaucratic networks. When formalized, the government has rights to inspect them and close them down if regulations are violated—here regulations are manifold and are more often than not subjected to interpretation and discretion of the official thus allotted for the job. Generally, Kirana Pasal owners are aware of few of those laws that are applicable to their businesses but there always remain minuscule provisions and clauses which the businesses would not be in compliance with, simply because of the volume and scattered nature of those regulations, which keeps the business always on offence. And as De Soto rightfully said, “informal economy is a by-product of over regulation and bureaucracy in the formal economy” and unless we do away with such hurdles there seems to be not enough hope for such small ventures to grow or even formalize their operations.

Secondly, empirical results have demonstrated that firms rank taxation as among the most severe obstacles to the long-term success of their enterprises. Likely, the shops in Nepal (if formalized) face a disproportionate burden from tax in comparison to larger firms. Those with turn over greater than 2 million rupees or income greater than two hundred thousand rupees are eligible to pay VAT tax of 13% and Corporate tax rate for Private Limited Co., Limited Co., Partnership Firm in the retail sector – a total of 25%. In many cases, not having books or audited accounts may result into the amount of tax to be paid being established by the tax official based his judgment, making use of a variety of indicators, including the observed standard of living of the entrepreneur. This might result in very high tax rates for enterprises.

Thirdly, there are standards that shops have to abide by. As much as the shops would be willing to do so in the light of protection of consumer rights, here too, the inability to bring in efficient intervention leads to losses on the part of the shop owners.

With problems as such to be encountered in terms of wishing to bring the shop into the formal stream, it seems that it is in the light of their own well-being that most decide to cling to their informal operations. Until and unless the aforementioned hurdles are done away with, the shops will remain informal because being so has more incentives than choosing to be otherwise.